Fitch Ratings: Markets, Not Coronavirus Mortality, Is the Risk to European Reinsurers

Prolonged stress on equity and credit markets combined with declines in interest rates would weaken earnings and erode capital headroom relative to ratings, which could lead to downgrades. In contrast, the risk to ratings due to mortality from COVID-19, the disease caused by the virus, is still remote.

Falling equity markets, widening credit spreads and declining interest rates are all negative for reinsurers’ capital. Each of these in isolation might have a limited effect on a reinsurer’s capital, but in combination they could have a material impact. Moreover, the combined impact could be greater than the sum of the standalone individual effects.

Regulatory Capital Sensitivities to Financial Markets

Based on end-2019 data except for Hannover Re, which is based on end-1H19 data

IFS: Insurer Financial Strength

Source: Fitch Ratings, companies

Falling equity markets are negative for reinsurance companies to the extent that the companies have unhedged equity exposure that could weaken their capital. However, most European reinsurers do not have significant exposure, partly due to high regulatory capital charges for equity risk.

Widening credit spreads and bond downgrades also deplete capital. European reinsurers’ bond portfolios are mostly highly-rated, but widespread downgrades could significantly weaken regulatory capital ratios and capital scores calculated in Fitch’s Prism factor-based capital model, due to higher asset-risk charges.

The coronavirus outbreak has triggered an investor flight to quality, depressing yields on highly-rated government bonds. This adds to pressure on reinsurers’ investment earnings and capital from already ultra-low bond yields

The major European reinsurers have relatively long debt maturity profiles, with refinancing needs spread over several years. They have a record of good access to the capital markets, but significant market dislocation would make it more costly to refinance maturing debt.

While financial market disruption could lead to reinsurer downgrades, we do not expect COVID-19 mortality to do so. We estimate that a 1-in-200 mortality shock of the type that reinsurers plan for, corresponding to tens of millions of extra deaths globally, would consume 5%-20% of major European reinsurers’ regulatory capital, and this still appears a remote scenario. Capital sensitivity to COVID-19 mortality is probably less than to general mortality given that COVID-19 fatality rates appear highly skewed to people of older ages with existing medical conditions.

Event cancellations due to the coronavirus may be partially covered by insurance, and reinsurers could face substantial losses. The largest upcoming event is the Tokyo Olympics, due to start in July, with insurance coverage likely to total about USD2 billion, according to industry experts. The risk is spread among several insurers and reinsurers but some reinsurers have exposure of hundreds of millions of dollars, equivalent to a meaningful proportion of recent annual earnings.

Most business insurance contracts cover only direct losses due to standard definable risks. This will largely shield the insurance sector from business-related claims. In particular, most business interruption cover is designed for interruption due to physical property damage and does not include interruptions for other reasons, even shutdowns forced by authorities. There will be some exceptions but claim exposures will be subject to policy limits.

Credit insurers face a rise in claims as businesses struggle amid a sharp reduction in economic activity due to the spread of the coronavirus and the measures being taken to slow it. However, the major European reinsurers have limited exposure. Credit and surety insurance represents a low-single-digit percentage of their global business, measured by premiums.

We do not expect travel insurance to generate significant losses for reinsurers given the claims limits and policy excesses, and particularly given that most travel insurance does not cover pandemic-related trip cancellations.

SOURCE: Fitch Ratings